Amazon And The Fantastic FANGs——A Bubblicious Breakfast Of Unicorns And Slippery Accounting

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At year end we posted a rant about the “Brobdingnagian” bubble embedded in Amazon’s market cap. On December 29th it was valued at $325 billion and had gained $180 billion or 55% of that towering figure in just the previous 12 months.

Self-evidently this was a flashing red warning signal that the end of the third great central bank fueled financial bubble of his century was near. AMZN and its three other FANG amigos had accounted for a $530 billion gain in market cap while the other 496 stocks in the S&P 500 had declined by an even larger amount.

That is, the apparently flat S&P 500 index of 2015 was hiding an incipient bear—–owing to a market narrowing action like none before. Compared to the Fabulous FANGs (Facebook, Amazon, Netflix and Google), the early 1970s Nifty Fifty of stock market lore paled into insignificance.

After the worst start to a year in history, some of the air has now been let out of the bubble. Amazon’s market cap is now down by $53 billion or 16% and the story has been roughly the same for the rest of the FANGs.

After Wednesday’s plunge, Goggle is now also down by $52 billion or 10%; Facebook is lower by $33 billion or 10%; and Netflix is off by $6 billion or 11%. In all, the FANGs have given back in eight trading days about $144 billion or 28% of their madcap gains during 2015.
AMZN Market Cap Chart

AMZN Market Cap data by YCharts

 

Call that a start, but in the great scheme of things it doesn’t amount to much. Consider the case of Amazon. Its PE multiple on LTM net income of $328 million has dropped from 985X all the way to…….well, 829X!

Likewise, it’s now valued at 97X its $2.8 billion of LTM free cash flow compared to 117X at year end.

In the same vein, Facebook’s LTM multiple on net income has dropped from 108X to 96X.

So the reason to revisit the FANGs, and the Amazon bubble in particular, is not because their market caps have come down to earth; it’s because once you get inside, another characteristic of late stage bubbles comes lurking front and center.

Namely, the tendency for the accounting income of momo tech stocks at bubble tops to be bloated with non-sustainable revenues and profits from Silicon Valley burn babies.

This time we call them Unicorns, and at last count there were upwards of 150 pre-IPO start-ups valued at $1 billion or more. At year-end, estimated “valuation” of the group stood at more than $500 billion. And, as befitting the blow-off stages of a financial bubble, they had been growing like topsy in the last 24 months:

I was reminded of this possibility by an excellent post by Dave Kranzler at Investment Research Dynamics. In a piece called “AMAZON dot CON” he took me to task for being too kind to Jeff Bezos’s ponzi accounting.

Among other things, Kranzler went all the way back to the beginning and offered an even more dramatic juxtaposition of the bubble in the stock versus the reality on the ground:

Throughout its 25-year history as a public stock, AMZN has delivered a cumulative total of $1.9 billion in net income to shareholders. Jeff Bezos made $16 billion on AMZN stock in 2014.

That’s right. So if AMAZN gained $180 billion in market cap during 2015 alone—or 95 times its cumulative earnings during the last quarter century—–then either some dramatic acceleration of earnings capacity occurred in 2015 or, as Kranzler put it—-

The more time I spend researching and observing AMZN, the more I’m convinced that it’s the biggest Ponzi scheme in the history of the stock market.

And on that score Kranzler hit the nail on the head. The ostensible reason that AMZN’s stock price soared in 2015 was due to the purported “scorching” performance of its cloud services division called AWS. I thought I had done a pretty good job of debunking that, but this turns out to be a case of the late night TV ad man——but wait, there’s more!

It turns out that the surging revenues of AWS may be due to the fact that AMZN is having unicorns for breakfast. But to establish the context, here is what we said at year end:

But this year’s $180 billion market cap eruption has absolutely nothing to do with its newly developed capacity for same day delivery of healthy treats for your pooch. This most recent rip was all about the purportedly “scorching” performance of its AWS division——-that is, Amazon’s totally unrelated business as a vendor of cloud computing services.

Indeed, CNBC recently gave air time to one of the most rabid analyst on the block, and this particular stock peddler from UBS left nothing to the imagination. Never mind whether anything emanating from that serial swindler and confessed criminal organization can be taken seriously, here’s what the man said.

AWS is technology’s second coming and is worth $110 billion. We know that because AMZN has recently been thoughtful enough to break out its financials.

They show AWS had sales of $2.1 billion in the September quarter and revenues of $6.9 billion on an LTM basis. So that puts its cloud computing business’ value at 16X sales. No sweat!

Moreover, this means that the balance of the company—–that is, its core E-commerce business—– is “only” valued at an apparently much more reasonable $215 billion. And by golly, said the UBS man, that’s just 2.3X sales. So what’s not to like?

Well, hold it right there. Someone forgot to do the math in all the excitement about AWS. Yes, the company’s release did show that AWS posted $1.42 billion of operating income or about 20% of sales during the September LTM period.

But consolidated operating income during the quarter was only $1.72 billion, meaning that by the lights of subtraction, Jeff Bezos’ great empire of E-commerce earned the microscopic sum of $300 million in operating income during its most recent year.

By the same magic of subtraction we can see that AMZN’s E-commerce business generated $94 billion of sales. This means that its operating margin was exactly 32 basis points.

That’s right—–after 25 years of crushing it on the E-commerce front, Amazon’s core business operating margin is truly a rounding error.

What now transpires is that upwards of 50% of that $7 billion of AWS revenue may be coming from Silicon Valley unicorns. That is, from companies that are buying cloud services with the proceeds of VC funding, not out of actual earned revenue.

Needless to say, when the Fed’s serial financial bubbles go bust in the night, these burn babies tend to disappear lickety-split, and with them the purchases of advertising, equipment and services that have temporarily bloated the revenues and income of their momo suppliers.

On this point Kranzler quotes a Silicon Valley insider who likens AWS’s “scorching sales” to what the big telecom equipment suppliers chalked up via sales to the CLEC’s prior to the dotcom bust:

I would like to introduce a meme before the sell side or buy side catches on.  As you know AMZN was up 100% this year as Bezos revealed the AWS business to the world.  The meme is this: AWS growth is unsustainable.  Not only is it unsustainable I predict that the sell side forward revenue growth rate for AWS will  go to zero or negative by Christmas next year.   It has come to my attention that 50% of AWS growth comes from start ups and my guess is that the majority of those dollars are Unicorns.  AMZN has been an indirect beneficiary of QE largess.  The Fed’s easy money created a bubble in VC funded start ups.  That funding peaked this year and is now in decline as the Unicorn bubble is bursting.  I expect this bubble to unravel fast as we are in the part of the cycle where the capital markets shut down for companies burning cash.

This set up reminds me of the easy money days of 1998-2000.  Then the investment world thought it was a good idea to fund a multitude of new telephone companies (CLECs).  These companies all rushed out and bought telecom equipment and helped to propel the stocks of Cisco, Nortel and Lucent.  These arms merchants were the must own large cap stocks of 1999 and 2000.  About 50% of their revenues came from the CLECs towards the end of the cycle.  The CLECs went away when the capital markets shut down and with it the revenues for these arms merchants went the way of the Dodo bird.

The problem for Amazon is that the Fortune 500 are not putting large portions of their business on the cloud yet nor will they soon.  Therefore there will be a big growth chasm that AMZN needs to cross.  I suspect the $150 billion in market cap being assigned to AWS is not anticipating such a growth hiccup.  Additionally,  I question how profitable this whole business is in the first place but for now lets just focus on the fact that revenues in the AWS division will roll over this year.  I am not short the stock but I will be stalking this and I predict my meme will come true and that AMZN will be one of the worst performing large cap growth stocks next year.

That raises a larger question, of course. Just how big is the pot of cash that the unicorns have been burning so prodigiously, and how much of it is being spent on tech service vendors like AWS, as well as equipment and advertising?  And who are the vendors—–especially of online advertising services?

FANGs anyone?

What we do know is that after a stock market bust new venture capital funding dries up rapidly and it quickly becomes evident as to who was swimming naked, to use Warren Buffett’s famous metaphor. Thus, at the peak in 2000, the combined market cap of Nortel and Lucent was in the range of $600 billion, but within two years Nortel was bankrupt and Lucent was a shadow of its former self. It turns out that equipment purchases were being funded with VC capital at burn rate start-ups, as well as by high flying frauds like WorldCom.

In the attached post Kranzler elaborates further on these and other points. But two of them deserve special emphasis.

I have argued that AMZN’s valuation at 100X free cash flow is borderline lunatic, but it seems the matter is even worse than it appears. That’s because it is raising a fair amount of cash through deals like Amazon Prime where membership cash comes in the front door today on the lure of free shipping and other services, which drain cash, down the road. Accordingly, Kranzler points out that AMZN’s cost of shipping relative to sales is steadily rising, reflecting the lagged effect of membership freebies.

UntitledIndeed, in the late stages of Fed bubbles, the optics of “growth” and what appears to be sizzling gains in accounting income can completely overwhelm what is really happening to the actual economics behind the curtain. In that regard he compares today’s cloud computing boom to the fiber optics bubble 16 years ago:

Here’s a funny fact on AWS [Amazon Web Services] that again everyone seems to ignore or miss. I have a company and our AWS bill is coming up for renewal and the prices have dropped 90%+ in 3 years. And yet, a hyper deflationary commodity, that is being sold in mass quantity to profit-less start-ups, is worth perhaps $150B or more of AMZN’s market cap.  Epic.

Cloud computing services is the contemporary version of fiber-optics.  Remember that business, which drove a large portion of the late 1990’s tech bubble?  Level-Three Communications (Warren Buffet), Qwest (Phil Anschutz), Global Crossing (A JP Morgan sponsored Ponzi business). The cost of accessing fiber optic networks dropped like a rock as fiber-optic overcapacity and technological advances invaded the business model.  The same dynamic has invaded cloud computing.

Global Crossing went bankrupt and reorganized into Level Three; Qwest renamed CenturyLink is a quasi-utility phone/communications company and survived the fallout from the fiber-optic bubble but its then-CEO, Joe Nacchio, was prosecuted for insider trading and financial fraud and spent six years in prison;  Level Three still operates but it’s stock, on a split-adjusted basis, dropped from a peak of $1,769 on Jan 31, 2000 to a current price of $53.

These examples show the type of hype, fraud and malfeasance which belie extreme financial bubbles.  I am highly confident that the same type of activities are occurring behind the “curtain” at Amazon.

As I said, there’s even more:

By Dave Kranzler at Investment Research Dynamics

Jeff Bezos’ greatest business trick is his ability to spin the illusion that AMZN is a money-making machine.  In fact, AMZN is remarkable  sales-generating machine ,but it costs the Company more than a dollar to generate a dollar of sales.Bezos1

All of a sudden in 2015 AMZN had become a cloud computing services phenomenon.  The last two earnings report showed a rate of growth in its AWS business and the stock rocketed higher.  Of course no one seemed to care that outright the AWS business represents less than 10% of AMZN’s total revenues.  And of course nothing is ever mentioned about the quality of AMZN’s AWS-derived sales.

The truth is, and Bezos never discusses this, that the majority of AMZN’s AWS contract revenue comes from Silicon Valley unicorns.  Most, and maybe all, of them will not be around in a few years.  Here’s an accounting of this from someone besides me:

I would like to introduce a meme before the sell side or buy side catches on.  As you know AMZN was up 100% this year as Bezos revealed the AWS business to the world.  The meme is this: AWS growth is unsustainable.  Not only is it unsustainable I predict that the sell side forward revenue growth rate for AWS will  go to zero or negative by Christmas next year.   It has come to my attention that 50% of AWS growth comes from start ups and my guess is that the majority of those dollars are Unicorns.  AMZN has been an indirect beneficiary of QE largess.  The Fed’s easy money created a bubble in VC funded start ups.  That funding peaked this year and is now in decline as the Unicorn bubble is bursting.  I expect this bubble to unravel fast as we are in the part of the cycle where the capital markets shut down for companies burning cash.  –  AMZN:  The Ghost Of XMAS Yet To Come

My AMAZON dot CON report goes into further detail about the problems with Amazon’s AWS business modelAMZNnew and why, at some point, the market value being assigned to the part of AMZN’s business model will likely largely evaporate this year.

Any question about the role Amazon stock plays in helping the Fed/US Government prop up the S&P 500?Untitled2

The more time I spend researching and observing AMZN, the more I”m convinced that it’s the biggest Ponzi scheme in the history of the stock market.

Throughout its 25-year history as a public stock, AMZN has delivered a cumulative total of $1.9 billion in net income to shareholders. Jeff Bezos made $16 billion on AMZN stock in 2014. Here’s the details:  Bezos’ Ponzi Scheme

Here’s what’s behind Bezos’ drive to transfer as much money from the stock market to his bank account: Bezos Has Amassed A $59 Billion Fortune – And Wants More. If you read through that article you’ll get a sense of what drives Bezos and how he operates.

Amazon is a Ponzi scheme in the sense that its business model requires sales growth every quarter in order to generate enough cash flowing in to the Company to enable it to pay the cash expenses flowing out of the Company.  This is one of the reasons AMZN is constantly running Prime membership 1st-year fee deals.  It needs the cash it receives upfront in order to help it fund cash payment Untitledexpense obligations.   The graph to the right shows one of AMZN’s basic problems.  AMZN offers free two-day shipping to Prime members.   Its cost of shipping eats up an increasing percentage of its sales revenues.   AMZN hides a lot of its expenses by making liberal use of the increasingly “grey” areas of GAAP accounting rules.  But you would never know this unless you dig deeply into the murky abyss of the footnotes to its financials.

The genius of Bezos is his ability bamboozle big investors and retail chimps into piling into his stock every time he announces another “big” idea.  The current massive bubble embedded in the valuation of AMZN’s stock is the $150 billion of AMZN’s $297 billion attributed to AMZN’s cloud  computing services business, “AWS.”   This is a business that represents about 7% of AMZN’s revenues.  That $150 billion is  21-times AWS’ trailing twelve month revenues and about 150-times  AWS’ trailing twelve month operating income.  Insane valuation multiples.

David Stockman published a piece last week which discusses the degree to which AMZN is an epic stock bubble.  However, even he is bamboozled by AMZN’s numbers. He gives AMZN credit for spending $11.6 billion on R&D.   This is what Bezos wants the market to believe.  Tech companies get a lot of stock market “cred” for showing high R&D “investment.”   But the $11.6 billion AMZN spends is not R&D.   Market professionals like Stockman are getting this “R&D” number from an expense line item in AMZN’s income statement called “Technology and Content.”  They automatically assume that number is R&D’s expense.  But it’s not. I like to dig into the bowels of 10Q and 10K filings and kill the market with truth.   This is from the footnotes to AMZN’s SEC-filed financials:

Costs to operate our AWS segment are primarily classified as “Technology and content.” Technology infrastructure costs consist of servers, networking equipment, and data center related depreciation, rent, utilities, and payroll expenses. These costs are allocated to segments based on usage. During Q3 2015, we expanded our technology infrastructure principally by increasing our capacity for AWS service offerings globally.

What analysts like Stockman assume to be R&D spending are, in truth, mostly the expense of operating AMZN’s website and its AWS business operations.  I detail this in my AMAZON dot CON report. In other words, AMZN is getting $10’s of billions of stock market love based on the idea that it is pouring billions into R&D – R&D that is in reality nothing more than standard operating expenses.

David Stockman and everyone else also use in their analysis the number that AMZN reports as “free cash flow.”  But I show in detail, based on using information that is found by digging through the footnotes in AMZN’s SEC-filed financials and by applying a deep understanding of GAAP accounting, that AMZN’s true cash flow is not even remotely close to the number used and reported by analysts and critics in their reports.  Again, my report is available here:  AMAZON dot CON.

As for the quality of revenues and operating income at AMZN’s cloud business, most of AMZN’s contracts are with Silicon Valley start-ups, most of which will not be around very long.  Moreover, the pricing for cloud computing services has undergone extreme price compression from competitive pressures. Here’s an anecdote from a contact of mine who runs a technology-based healthcare company:

Here’s a funny fact on AWS [Amazon Web Services] that again everyone seems to ignore or miss. I have a company and our AWS bill is coming up for renewal and the prices have dropped 90%+ in 3 years. And yet, a hyper deflationary commodity, that is being sold in mass quantity to profit-less start-ups, is worth perhaps $150B or more of AMZN’s market cap.  Epic.

Cloud computing services is the contemporary version of fiber-optics.  Remember that business, which drove a large portion of the late 1990’s tech bubble?  Level-Three Communications (Warren Buffet), Qwest (Phil Anschutz), Global Crossing (A JP Morgan sponsored Ponzi business). The cost of accessing fiber optic networks dropped like a rock as fiber-optic overcapacity and technological advances invaded the business model.  The same dynamic has invaded cloud computing.

Global Crossing went bankrupt and reorganized into Level Three; Qwest renamed CenturyLink is a quasi-utility phone/communications company and survived the fallout from the fiber-optic bubble but its then-CEO, Joe Nacchio, was prosecuted for insider trading and financial fraud and spent six years in prison;  Level Three still operates but it’s stock, on a split-adjusted basis, dropped from a peak of $1,769 on Jan 31, 2000 to a current price of $53.

These examples show the type of hype, fraud and malfeasance which belie extreme financial bubbles.  I am highly confident that the same type of activities are occurring behind the “curtain” at Amazon.

Clearly, from the graph above, the Fed uses AMZN as one of its props to hold up the S&P 500 in order to maintain the illusion that the economy is fine.  But at some point, just like with every bubble stock in history, the gravitational pull of fundamentals will engulf AMZN’s stock price and send it plummeting.  Perhaps this has already begun:

AMZN11

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